I'm Political Economy editor at Forbes, editor of RealClearMarkets.com, plus a senior economic advisor to Toreador Research & Trading. I have book on how the economy works, Popular Economics: What LeBron James, the Rolling Stones and Downton Abbey Can Teach You About Economics that is set for release in April of 2015. I have a weekly column on Mondays at Forbes.com.

A popular refrain on the left AND right ever since the financial crisis* is that to ensure nothing like it happens again, the banks must be broken up. Explicit here is that if no bank is too large, no one entity can ‘threaten the financial system’ if calamity strikes. They also presume that smaller banks mean no more bailouts. Both are nice thoughts, yet totally divorced from reality.

For one, U.S. banks aren’t all that large. In terms of assets, there are only two among the world’s ten biggest (JP Morgan Chase and Bank of AmericaBank of America), and they rank 9th and 10th. The rest of the largest banks are foreign owned, so if you believe the ‘Mother of All Great Depression,’ ‘Crush the Financial System’ narrative as Ben Bernanke and the break-up-the-banks crowd do, sorry, but ‘systemic risk’ has a foreign address.

Never explained – at least very well – is why big is bad. In most other industries (particularly lightly regulated ones) a company grows large mainly because it’s serving the needs of the marketplace well. Banking, on the other hand, is a highly regulated industry, so it’s fair to assume that size at least to some degree is a function of political pull. Of course that’s one of many reasons why banks shouldn’t be broken up, as will be explained further along.

But first, lost on the break-up-the-banks crowd are notions of return-on-equity, profit margins, earnings, and other things that investors care deeply about. No investors, and no companies. Simple as that.

Applied to banks, if you break them up you’re almost by definition reducing their profit margins. Boost their capital requirements? To do so is to similarly reduce their ability to reward investors with high returns, at which point investment will flow to unregulated (this is a good thing) financial institutions, not to mention larger foreign banks not so encumbered.

It must be stressed that banks are large because economies of scale (geographical diversification is said to be another positive factor) make it smart to grow. If by government decree banks are broken up, it’s only a matter of time before they – through acquisitions – start swallowing each other once again in order to achieve the economies of scale, profitability, and other forms of return craved by investors.

To the above some will surely say that regulations will ‘ensure’ that banks will never grow large again. Doubtful, but even if it’s true, implicit in such a suggestion is that by regulatory decree banking will be an unprofitable, talent-free sector. Sorry, but if you limit the ability of businesses to grow, along with their profitability, you’re by definition limiting how much they can pay their employees. If the pay is low, the talent will go elsewhere. Banks as the new GMs and Chryslers? It’s not very far-fetched if the break-up-the-banks crowd gets its way.

Talent-free banks acting as utilities might appeal to some. They would even appeal to me in a certain sense. Bernanke et al told us that absent the bailouts of the banks that credit would dry up on the way to a staggering recession, but the real truth is that most finance and lending has long occurred outside the banking system. In that case, if politicians want the banking sector to resemble the U.S. automobile industry, fine.

The best financial minds will depart the banks in even greater numbers than they are, as will investment and deposits. Banks will become even more politicized in their lending because lacking talent and serious investment, they’ll only exist at the pleasure of politicians.

To the break-up-the-bank gang, seemingly all of this is ok because they want to put bailouts in the rear-view mirror. That’s fine, this writer does too, but they’re dreaming if they think bailouts will end simply because banks will have been broken up.

The reason for this is basic, though perhaps contrary to what most are used to reading. Put simply, banks aren’t heavily regulated because they’re not politically connected, in truth they’re heavily regulated precisely becausethey are politically connected. And because they are, connected banks will either skirt the rules on size or they’ll shrink their way to market irrelevancy; their ongoing existence a function of their ability to please their political masters.

In short, shrunken banks will face profit pressures for being made artificially small, for being less profitable they’ll be more reliant on their political angels, and when they inevitably fail due to smaller margins, politicized loans, and talentless management, their ties to the political class will ensure their ongoing survival. If government can force banks into lower margins, rest assured that it will pay when these politically potent entities start to implode. Conversely, if the feds look the other way as the banks merge again in order to compete, any failures will fall at the doorstep of a federal government that allowed all the M&A activity. Hello bailouts yet again.

What’s comical about all this is how unnecessary it all is. Implicit in the break-up-the-banks mentality is that if a financial institution grows too large that its failure will send the economy into a multi-decade funk. The very supposition would be very funny if it weren’t so sad, and if it didn’t carry with it such dire, economy-suffocating implications. Many people in power do believe this narrative, including our present Fed Chairman. As Bernanke put it to then House Speaker Nancy Pelosi about propping up the banks back in 2008, “”if we don’t act in a big way, you can expect another great depression, and this time it is going to be far, far worse.”

Back to reality, for those fearful of one, ten or 100 financial institutions’ failures crushing the economy for decades, simply GoogleGoogle post-WWII photos of Japan and Germany. Both countries were literally reduced to rubble during the war, but within a few years of its end, and bolstered by falling tax rates alongside stable money, both country economies ascended to some of the world’s largest in fairly short order.

Post Your Comment

Post Your Reply

Forbes writers have the ability to call out member comments they find particularly interesting. Called-out comments are highlighted across the Forbes network. You'll be notified if your comment is called out.

Comments

Excellent article but you busted the wrong financial myth. There was no TBTF bailout. With the exception of Citi the biggest banks acquired their problems and size with eager encouragement from Uncle Sam. In Citi’s case while it didn’t officially go BK it’s shareholders were effectively wiped out. All of the TBTF including Citi paid back every cent of the supposed bailout with interest in less than a year. What bailout are the break em up crowd talking about?

Excellent article but you busted the wrong financial myth. There was no TBTF bailout. With the exception of Citi the biggest banks acquired their problems and size with eager encouragement from Uncle Sam. In Citi’s case while it didn’t officially go BK it’s shareholders were effectively wiped out. All of the TBTF including Citi paid back every cent of the supposed bailout with interest in less than a year. What bailout are the break em up crowd talking about? They got a bridge loan not a bailout and most did the country a favor absorbing smaller more culpable institutions.

Don’t worry, Jesus Christ is going to break up the banks(ters) forever. Banks have enslaved humanity since the days of the Babylonians. Jesus Christ’s only physical action was tossing the tables, money and driving out the slave masters.

The perpetual debt system of the earth is meant to implode. The system itself has a time limit and we are at the limit. This is all been pre ordained by the money changers. They don’t know exactly when the system will implode but they know for sure it will and sooner than later. That is when real luciferian totalitarianism will take over the earth via a new world financial and governmental system.

American banks will be the first to collapse to start this world party.

So only those who believe in Jesus will be saved from banisters. Interesting perspective. No other religious person could do it? And when exactly is this going to happen? This banking issue has been around for more than a few hundred years? How about instead of hoping that one person’s religious authority do something about it, people actually do something about the problem. Join a credit union perhaps…

putting the world under a one world bank, installing it under a one world currency, then no currency at all, a cashless sociaty, this is what the holy bible predicted this 2000 years ago, if you were a betting man then, and lived to this day, you could have put one dollar bet and made one billion to one with the odds of this ever accuring, so when this takes place, and it will, because the wheel is now in motion, you could be counting your money very soon

I’ll take your bet and give you those odds. So if the Bible predicted this 2000 years ago, did it predict the year? Heck, I predicted the Cubs would win the world series 30 years ago. I didn’t say when, so when my prediction comes true, it will clearly have been an accurate prediction. I have no idea what this cashless prediction is based upon, but my guess is that people who believe that have been hoarding silver, bullets, and non-perishable foods for years with no payoff. And the hope is that the world as we know it would crash so they could live is some sort of post-apocalyptic utopia with their silver buying all sorts of goods and their bullets fending off the hoards at their door?

Excellent points here Mr. Tamny. The overall best policy would be this: Screw up and you lose. No bailouts. Financial firms would then astonish everyone with their fiscal probity. But summoning the political will needed to follow that course is by far the biggest problem …

An interesting article. I agree that break-up is not the best idea, but what about just getting back to the separation of investment vs commercial banking? I think the biggest issue worrying Average Joe concerns his bank deposits, so separating that from the rough & tumble world of investment banking might set Joe’s mind at ease. As for bailouts, the article hits it on the nose with investor led, or big money led bailouts. Rewind to the investor led LTCM bailout in the late 90′s – although it didn’t seem to change mindset regarding systemic risk, it was accomplished without much ado and more of the same would definitely direct big money’s attention toward systemic risk.

I don’t buy the seperation argument. For one it was hybrid banks/investment banks that were best situated to buy the sick in ’08. For two, banks were in trouble for doing that which they could do well before Glass-Stegall’s repeal.

That’s cute, but your entire argument is predicated on the belief that banks are in any way comparable to companies that produce real goods, or employ large numbers of middle-class workers. Comparing Wall Street to GM is like comparing a Bentley to a Kia, and then pretending like there’s a chance that someone will cross-shop the two. Banks are useless machines of capital re-investment…they’re siphons designed to slowly leech money out of our economy and deposit it in the Cayman islands. There isn’t a single person in America who doesn’t make a six-figure income who wouldn’t be better off if Wall Street all but burned to the ground.

I know Wall Street investors have talked themselves into believing that what they’re doing is “important.” It’s how they live with themselves. But that’s a delusion clung to by those who are rich beyond anything they’ve honestly earned. It’s nothing more than the modern equivalent of Divine Right, and moral insurance against questioning whether the ends justify the means. So, get real…nobody needs mega-banks, the economy wouldn’t disintegrate if these cash siphons didn’t exist, and the only people who would suffer in the slightest would be those for whom “millionaire” just isn’t enough.

Banks allocate capital. That’s very important. If it weren’t, investment banking in particular wouldn’t pay so well. I know, I know, you’ll say investment banks force these fees which is laughable. Indeed, if investment banks were so powerful they wouldn’t have needed bailouts in ’08. They do very important work, and precisely because their work is important they should be allowed to fail when they fail. Successful industries allow failure. Wall Street and banks are no different.

I wonder why there are no big studies of systemic risk by having a government that is too big to fail. Government that bails companies out is part of the problem of too big to fail. If government would have never bailed any company out, investors would know they they and the board is only stop gap, preventing companies from bombing. Management would be required to make prudent risks or be immediately terminated. Government is part of the problem, there are many situations where government actually creates more risk and then regulates the industry more because of their own incompetence.

Of course, the correlation between the repeal of Glass-Steagal and the virulent rise of paper products and the creation of huge finance drive bubbles completely goes past Mr. Tammy. Mr Tammy is a columnist and a trader; he produces nothing but opinions and paper transactions. In short, he is one of the tape worms in the monetary flows. I suspect Mr. Tammy has never participated in the real economy, you know creating a product people want to buy and creating jobs in the process. As such, is it any surprise he would defend the king of monetary tape worms, Wall-street? He is worried about wall-street’s profits! He’s worried that they won’t be able to such as much out of the productive for their own consumption! I am not a lefty, anything but! I am a fierce fiscal conservative and avid supporter of free-enterprise. But Mr. Tammy, wallstreet is not the economy and speculation and manipulation are not productive enterprises. The current for of finance in the US is NOT representative of free-enterprise! It represents a wallstreet-DC oligarchy. Go pitch your “preserve the status quo” to someone dumb enough to by it. Or better yet, go do something useful, make something of your life!:)

You’re kidding, right? Before the banking crisis, $850 billion in fiduciary money and token coins circulated to support a $13.8 trillion economy. That means cash constituted 4.5% of the economy.

So how did Americans manage to rack up $13.8 trillion in sales? Credit. Credit has built the United States of America. Credit is the engine that brings the future into the now and bonds man to man in mutual trust.

Today, after Bernanke floodding the economy, there now is $1,124.9 billion cash circulating for a $16 trillion economy. That means cash constitutes 7% of the economy.

Still where did all those sales come from without credit?

A banker is a trader who buys cash and other debt and sells credit. What a banker does it no different than what a retailer does who sells dresses by selling a right of action as evidenced by an invoice and buying merchandise from a wholesaler.

Without credit, there would not be labor specialization. Almost everyone would be subsistence farmers or surfs or dead.

“Glass-Steagall, were it still in place, would have done nothing to restrain banks from making the errors they made.” You say that with such authority and certainty…….clearly marking you as someone lacking substance. Just because you make such a ridiculous, infantile assertion does not make it so, John. Glass-Steagal reduces the size of the sandbox wallstreet parasites plumb, I suspect it would have had a positive impact. And it would do it with law, not regulation.

I disagree with you about Glass-Steagall, it would have definitely had an impact as far back as the 80′s when everything became deregulated and then 1999 the final regulations thrown out.

Also, you don’t even mention credit unions I know folks who live a decent life and have their money in Credit Unions and have no need for large banks. They are far more community oriented and growing stronger in certain places. I believe Elizabeth Warren is on the right track as well as John McCain.

http://video.cnbc.com/gallery/?play=1&video=3000182337

I also look just at the amount of intelligent young people leaving University with skills for various types of work going into banking because they will make much more money. When I was growing up being a banker was quite possibly the most boring job in the world and then bye bye regulations and hello greed, so now people who could become great scientists, engineers etc take themselves out of that and become investment bankers. How can this be any good for society as a whole?

The capitalist system functions in some degrees quite rightly, but no regulations on banks? You are truly drinking the Kool-Aid. I live in Brazil now which has some of the biggest banks in the world and banks make tons of money here off of consumers mainly from high fees etc..Interest rates are insane here mainly on credit and the banks have very few regulations which benefit the consumer here. The cost of living is very high here and the banks are the ones making the majority of money. It’s a capitalist nightmare and the banks are like cartels.

FALLACY: In most other industries (particularly lightly regulated ones) a company grows large mainly because it’s serving the needs of the marketplace well.

REALITY: Firms grow larger for all manners of reasons, chief among is the willingness of financial backers to fund acquisition of competitors.

In a true free-market economy, profits would be hard to come by for any firm as natural distribution of capital adjusting to technological advances leading to efficiency would happen. Capital would get allocated across all firms competing on offers based on ever-changing consumer preferences rather than through regulatory capture.

One should only see large firms with few firms extant in dying industries. In dying industries, one should see an ongoing drain of capital. In advancing industries, one should see many firms, an influx of capital bet across many techniques and methods employed by competitors.

Until men dispense with the false story of economics spouted by academicians and embrace authentic economics, men shall fail in their understanding of how it all works.

Two great forces govern the whole of authentic economics, the Axiom of Profit and the Law of Prices. Any purported economic analysis that does not arise from both, fails to describe reality.

The Axiom of Profit holds the sum of sales must at least equal the cost of production or in short order, a producer goes to ruin. The Law of Prices holds that the winning bids of demand in the face of supply set the price.

It should be noted that capital means cash, credit, labor (as labor is the working man’s capital), rights of action, algorithms — anything that acts as a fountainhead in the quest of producing surplus arising from efficiency which leads sales on prices governed by the Law of Prices that at least equal the cost of that production.

It is quite likely that too much capital is allocated to commercial banking owing to the explicit function by the Federal Reserve to bailout commercial bankers with conjured checking account credits when bankers fail as businessmen and their banks go to ruin. It is quite likely then that the entire commercial banking sector needs shrink.

It is quite anti-free market about a service established by the largest players exists for the sole purpose of maintaining the existence of those players.

When dealing with the fundamental IMbalance of both power and information between individuals and highy complex professional institutions (like banking and investment) an outside system of restraint is needed to prevent bad acts.